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Updated, 9:44 p.m. | The convictions had racked up in recent years, 85 people all told, as Manhattan prosecutors swept through Wall Street with what they described as clear-cut evidence of insider trading.

But on Wednesday, a federal appeals court upended the government’s campaign. And in the process, the court rewrote the insider trading playbook, imposing the greatest limits on prosecutors in a generation.

In a 28-page decision, the United States Court of Appeals for the Second Circuit in Manhattan overturned two of the government’s signature convictions, the case against the former hedge fund traders Todd Newman and Anthony Chiasson, who were tried together. Citing the trial judge’s “erroneous” instructions to jurors, the court not only reversed the convictions but threw out the case altogether.

The unanimous decision by a three-judge panel — the first higher court rebuke of an insider trading case filed by Preet Bharara, the United States attorney in Manhattan — offers a blueprint for lawyers to defend future insider trading cases. It could also portend a partial unraveling of Mr. Bharara’s insider trading crackdown, a rare bright spot for the government as it came under attack for going soft on Wall Street after the financial crisis.

The appellate ruling hinged on a 30-year-old United States Supreme Court case, Dirks v. S.E.C., that has long been the cornerstone of insider trading law. Clarifying the vagaries of that ruling, the appellate decision drew a new and more defined line that curtails the boundaries of insider trading liability.

The appellate court faulted the judge who had presided over Mr. Chiasson and Mr. Newman’s trial, saying that he had misinterpreted the Supreme Court case and set too low a bar for conviction when instructing jurors.

Unlike the trial judge, the appellate court ruled that Mr. Chiasson and Mr. Newman needed to know that insiders at technology companies were improperly leaking confidential information to hedge funds in exchange for some “personal benefit.” While they profited from the information, Mr. Chiasson and Mr. Newman were so far removed from the initial tips at Dell and Nvidia, the appellate court ruled, that they would not have known of any such benefit.

“Although the government might like the law to be different, nothing in the law requires a symmetry of information in the nation’s securities markets,” Judge Barrington D. Parker wrote on behalf of a panel that also included Judge Ralph K. Winter Jr. and Judge Peter W. Hall.

The decision, a stunning blow to prosecutors, reverberated throughout the legal world on Wednesday.

Two camps formed: Prosecutors who complained that the ruling will tie their hands in pursuing Wall Street crime, and defense lawyers who expressed delight after years of lamenting what they saw as government overreach.

From both sides, a consensus emerged that the ruling would have a chilling effect on insider trading prosecutions.

“This decision will dramatically impact how the government investigates and charges traders, not only criminally but also civilly,” Andrew Michaelson, a lawyer with Boies Schiller & Flexner and a former prosecutor who worked on several insider trading cases, said.

Mr. Bharara said in a statement that “today’s decision by the Court of Appeals interprets the securities laws in a way that will limit the ability to prosecute people who trade on leaked inside information.” He added that he was considering “options for further appellate review,” a nod to a possible Supreme Court appeal, a decision that would ultimately rest with the United States solicitor general.

Despite the setback on Wednesday, Mr. Bharara’s office has piled up a nearly undefeated record at trial. And most of the 85 convictions for insider trading will stand.

The appellate court, in a footnote, implied that prosecutors steered Mr. Steinberg’s case to Judge Sullivan because he would be predisposed to give the same flawed jury instruction as he had done in the trial of Mr. Chiasson and Mr. Newman. In April, at a hearing on the appeal, the three-judge panel raised concerns about the unsavory courthouse practice that is known as judge shopping.

Judges wield unusual sway in shaping insider trading law, in part because the act of insider trading is not explicitly prohibited in a federal statute. In its place, a patchwork of legal opinions and regulations define the law. The situation has prompted some legal experts, including Supreme Court Justice Antonin Scalia, to fault Congress for leaving it up to the courts and regulators to sort out the nuances of the law.

Steven A. Cohen, the founder of SAC, once remarked in a deposition that insider trading laws were “very vague.”

On Wednesday, lawyers for Mr. Chiasson and Mr. Newman applauded the appellate court decision — and its wider consequences.

“Today’s decision is a resounding victory for the rule of law and for Anthony Chiasson personally,” said Gregory Morvillo, who represented Mr. Chiasson along with Alexandra A. E. Shapiro, and Mark F. Pomerantz, a lawyer at Paul, Weiss, Rifkind, Wharton & Garrison, who argued the appeal.

Mr. Newman’s lawyers at Shearman & Sterling, Stephen Fishbein and John A. Nathanson, said they were “relieved but not surprised by today’s decision, which clearly establishes Todd Newman’s innocence on all charges.”

Mr. Steinberg’s lawyer, Barry H. Berke, predicted that his client will be among those to benefit from the decision. “The Second Circuit’s decision clearly means that Michael Steinberg is innocent of any crime and his conviction will be vacated as well,” Mr. Berke said.

(Late Wednesday, the appeals court lifted a stay on Mr. Steinberg’s appeal, signaling that a decision on his case could come soon.)

The dismissal of the case against Mr. Chiasson and Mr. Newman could in theory also lead to other dismissals — those of cooperating witnesses who pleaded guilty to trading on the same thread of information about Dell and Nvidia.

The appeals court concluded that not only were Mr. Chiasson and Mr. Newman unaware that insiders had received a benefit, but that no such benefit had ever existed. Indeed, prosecutors never charged the sources at Dell and Nvidia. And so, if no crime was committed in passing on the information, anyone who pleaded guilty to receiving that information could subsequently challenge their plea.

The ruling challenged the very notion of what constitutes a benefit. In the past, prosecutors had argued that mere friendship is enough to prove that a tipper got a benefit from passing on an illegal tip to a friend. And in this case, the benefit was that the Dell insider received career advice from a trader.

But the appellate court took issue with that low standard, saying the government must also show that the tipper expected to receive something “of some consequence.”

Jonathan R. Streeter, a lawyer at Dechert who was one of the prosecutors under Mr. Bharara who secured the insider trading conviction of the Galleon Group co-founder Raj Rajaratnam, said the appellate ruling would complicate the prosecution of insider trading. “It used to be all the government had to do to prove a benefit was show the people involved were friends — and now they must show a tangible benefit, and that’s a big change.”

The ruling also questioned the government’s decision to take aim at traders like Mr. Newman and Mr. Chiasson who did not directly receive the insider tips. Prosecutors placed them at the end of a four- or five-person chain of information that started with insiders at the technology companies, Dell and Nvidia, and wound its way through a network of traders before reaching Mr. Chiasson and Mr. Newman.

But in slamming the “doctrinal novelty” of recent insider trading prosecutions, the appeals court stated that “the government has not cited, nor have we found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading.”

Photo

Preet Bharara, the United States attorney in Manhattan, outlined charges in 2012 against Todd Newman, Anthony Chiasson and five others.Credit Robert Stolarik for The New York Times

A jury convicted Mr. Newman and Mr. Chiasson in 2012 of participating in what prosecutors called a “circle of greed.” The appellate court allowed both defendants to remain free on bail while awaiting the outcome of their appeal.

The dismissal of the case also raises questions about the November 2010 raids of Level Global and Diamondback Capital Management by the Federal Bureau of Investigation. Soon after the raid on Level Global, the hedge fund, which was started by Mr. Chiasson and David Ganek, shut down, in part because of requests by investors to redeem their money after the raid. Mr. Ganek was never charged with any wrongdoing by federal authorities.

Diamondback, where Mr. Newman was a portfolio manager, continued to operate for another two years, but it decided to close its doors in December 2012 after receiving a wave of investor redemptions.

Mr. Ganek chided the government in a statement on Wednesday. “For the dozens of my high-integrity colleagues at Level Global who lost their jobs and their reputations because the F.B.I. improperly raided our firm in this now-discredited fishing expedition, today’s legal vindication is a reminder how prosecutorial recklessness has real impact on real people,” he said.

A version of this article appears in print on 12/11/2014, on page A1 of the NewYork edition with the headline: Appeals Court Deals Setback to Crackdown on Insider Trading.